Credit of a Different Breed: Credibility

It's clear that the past 6 years of financial turmoil have done nothing to remove the blinders of policy makers.

"They say that if you're playing poker and don't know who the sucker is, chances are it's you. For those currently holding trading cards, the stakes have never been higher. Over the last few weeks, as risk chips stacked around the table, investors have been forced to call the bluff of some of the savviest players in the global game."--Todd Harrison, The Credit Card (2007)

We lived through a decade in a cave man's world; surrounded by shadows that were thought to be truth but instead were filled with false realities. Our fate going forward will be predicated and hopefully dedicated to turning our country's course. As Todd thoughtfully wrote this morning, "...the bitter pill is the harder one to swallow, but proves to be a valuable lesson learned. It's not too late to learn... but it seems like we'll be force-fed that lesson the hard way."

As I watched Fed Chairman Ben Bernanke get blasted again in the media yesterday, I thought it would be worthwhile to recall how we got here and reminisce about who was previously running the ship. I pulled up former chairman Alan Greenspan's semiannual Monetary Policy Report to the Congress delivered February 16, 2005. History is a sobering sorrow. No longer can we extend and pretend. It's the fourth quarter and we need a play maker.

The evidence broadly supports the view that economic fundamentals have steadied. Consumer spending has been well maintained over recent months, buoyed by continued growth in disposable personal income, gains in net worth, and accommodative conditions in credit markets. Households have recorded a modest improvement in their financial position over this period, to the betterment of many indicators of credit quality. Low interest rates and rising incomes have contributed to a decline in the aggregate household financial obligation ratio, and delinquency and charge-off rates on various categories of consumer loans have stayed at low levels.

The sizable gains in consumer spending of recent years have been accompanied by a drop in the personal saving rate to an average of only 1 percent over 2004--a very low figure relative to the nearly 7 percent rate averaged over the previous three decades. Among the factors contributing to the strength of spending and the decline in saving have been developments in housing markets and home finance that have spurred rising household wealth and allowed greater access to that wealth. The rapid rise in home prices over the past several years has provided households with considerable capital gains. Moreover, a significant increase in the rate of single-family home turnover has meant that many consumers have been able to realize gains from the sale of their homes. To be sure, such capital gains, largely realized through an increase in mortgage debt on the home, do not increase the pool of national savings available to finance new capital investment. But from the perspective of an individual household, cash realized from capital gains has the same spending power as cash from any other source.

More broadly, rising home prices along with higher equity prices have outpaced the rise in household, largely mortgage, debt and have pushed up household net worth to about 5-1/2 times disposable income by the end of last year. Although the ratio of net worth to income is well below the peak attained in 1999, it remains above the long-term historical average. These gains in net worth help to explain why households in the aggregate do not appear uncomfortable with their financial position even though their reported personal saving rate is negligible.

I have mentioned before that the federal government has failed us in the arena of crisis prevention. In victory we are often too complacent and conversely overly critical in defeat. They turned a blind eye to the dot com bubble, and they opened up the flood gates by repealing Glass Steagall and declaring every American should be a homeowner. I support this and believe it's in our country's best interest to do so, as we'd all have skin in the game. But it must be done responsibly. They dismissed the housing/credit bubble, as witnessed above. It is often stated in this community that where you stand is a function of where you sit. Our feet must be rooted in deep as we are repeating our mistakes of the past, not repealing them. Now is the opportunity for a great debate on our country's framework for moving forward. I support a reduction of the so called "big government". We must allow a free market to follow its chosen path.

In its annual report, the Bank for International Settlements said that monetary policy should be brought back to normal quickly and countries should act urgently to close budget deficits. The BIS report, however, warned policymakers not to expect a normal recovery because much of the pre-crisis growth had been unsustainable and capacity will have been destroyed for good, particularly in the finance and construction sectors in some economies.

Stephen Cecchetti, BIS chief economist, said the result is that the "output gap", the gap between what an economy is capable of producing and that which it is actually churning out, "has disappeared or is disappearing". But it is not just in rapidly growing emerging economies that the BIS called for higher interest rates and faster deficit reduction. Rising food, energy, and other commodity prices underscored the need for central banks around the world to begin raising interest rates, perhaps even more rapidly than they brought these down, the BIS said in its report. "Highly accommodative monetary policies are fast becoming a threat to price stability," it concluded. The fact that interest rates have been so low for so long also introduces new risks into the world.

"The persistence of very low interest rates in major advanced economies delays the necessary balance sheet adjustments of households and financial institutions," the BIS said. "And it is magnifying the risk that the distortions that arose ahead of the crisis will return." The BIS view runs counter to that of the Federal Reserve, its largest member central bank, which made it clear last week that its interest rates would remain extremely low for an "extended period". "One wonders how long its current policy can be sustained," the BIS mused. The BIS message to governments was just as critical. Efforts to reduce deficits so far were insufficient, the report said, and countries needed to build fiscal buffers to help countries withstand future financial crises.

History has a way of repeating itself; humans continually make the same mistakes time and again. It's clear that the past 6 years of financial turmoil have done nothing to remove the blinders of policy makers. The U.S. will be the last country on the globe to raise interest rates and Adam Smith's "Invisible Hand" will have dire consequences for our economy.

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